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Borrowing to Finance Public Investment? The 'Golden Rule of Public Finance' Reconsidered in an Endogenous Growth Setting

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  • Alexandru Minea
  • Patrick Villieu

Abstract

In this paper, we look for long-run and short-run effects of fiscal deficits on economic growth and welfare in a standard endogenous growth model. We show that, under very general hypotheses, the 'golden rule of public finance', which allows a government to run public-investment-oriented fiscal deficits, leads to a lower balanced-growth path in the long run, and eventually in the short run, compared with balanced-budget rules. Welfare effects are more difficult to assess, and depend on the form of the utility function. Our model shows that debt rules such as the golden rule may improve (if the consumption elasticity of substitution is 'low') or weaken (if the consumption elasticity of substitution is 'high') intertemporal welfare. Consequently, a balanced-budget rule does not necessarily dominate debt rules from the point of view of welfare, while it does from the point of view of long-run economic growth.
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Suggested Citation

  • Alexandru Minea & Patrick Villieu, 2009. "Borrowing to Finance Public Investment? The 'Golden Rule of Public Finance' Reconsidered in an Endogenous Growth Setting," Fiscal Studies, Institute for Fiscal Studies, vol. 30(1), pages 103-133, March.
  • Handle: RePEc:ifs:fistud:v:30:y:2009:i:1:p:103-133
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    Cited by:

    1. Tetsuo Ono & Yuki Uchida, 2016. "Human Capital, Public Debt, and Economic Growth: A Political Economy Analysis," Discussion Papers in Economics and Business 16-01-Rev.3, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP), revised Oct 2017.
    2. Tamai, Toshiki, 2016. "Public investment, the rate of return, and optimal fiscal policy in a stochastically growing economy," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 1-17.
    3. E. EHRHART & Alexandru MINEA & Patrick VILLIEU, 2009. "Deficits, Seignorage and the Growth Laffer Curve in Developing Countries," LEO Working Papers / DR LEO 118, Orleans Economics Laboratory / Laboratoire d'Economie d'Orleans (LEO), University of Orleans.
    4. Philippe Darreau & François Pigalle, 2011. "Ponzi game in OLG model with endogenous growth and productive government spending," Economics Bulletin, AccessEcon, vol. 31(3), pages 2509-2520.
    5. Philippe Darreau & François Pigalle, 2011. "Ponzi game in OLG model with endogenous growth and productive government spending," Post-Print hal-00785437, HAL.
    6. Jan Hanousek & Evžen Kočenda, 2011. "Public Investment and Fiscal Performance in the New EU Member States," Fiscal Studies, Institute for Fiscal Studies, vol. 32(1), pages 43-71, March.
    7. Alfred Greiner, 2010. "Does the 'Golden Rule of Public Finance' imply a lower long-run growth rate? A clarification," Economics Bulletin, AccessEcon, vol. 30(2), pages 975-982.
    8. Michał Konopczyński, 2013. "Fiscal policy within a common currency area – growth implications in the light of neoclassical theory," Contemporary Economics, University of Finance and Management in Warsaw, vol. 7(3), September.
    9. Akira Kamiguchi & Toshiki Tamai, 2017. "Public Investment and Golden Rule of Public Finance in an Overlapping Generations Model," KIER Working Papers 971, Kyoto University, Institute of Economic Research.
    10. Alfred Greiner, 2013. "Debt and growth: Is there a non-monotonic relation?," Economics Bulletin, AccessEcon, vol. 33(1), pages 340-347.

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